Dodd-Frank

On August 5th, SEC will vote on a rule that would publish the ratio of CEO compensation to the typical worker of their own firm. This disclosure is required by Dodd-Frank, but, as with many laws, the details and implementation makes all of the difference in the world. SEC has delayed the implementation of this requirement, but I don’t really know why, other than CEO’s don’t like the idea.

I don’t like the idea because it unnecessarily target the CEO over other top executives. The likely comparison will be made between the CEO and an average of some pool of individuals, which is unfair. The better comparisons are with individuals against individuals or pools against pools.

I’m in favor of pools. The pools should be large and the distinction should be simple and indicative of something important. If the pay disparity is what the SEC wants to highlight because it feels that bigger disparities lead to more compliance issues, then they need to identify what is driving the disparities within the organization. Across the board, the biggest portion of disparity is equity compensation. The two pools should something quite simple. My suggestions: compare average total compensations where more than 50% of the total compensation is equity versus less.

Here’s the other problem with this disclosure: what is defined as the organization. I’m assuming Goldman Sachs does not hire any janitors. Janitors are employees of an outside firm. But Goldman Sachs wouldn’t exist without working in buildings of some sort. So, in terms of running the company called Goldman Sachs, some manager has to decide what janitorial company will be responsible cleaning their offices. As long as having offices is part of Goldman Sach business model, office cleaning services are part of its business. But legally, those janitors don’t work for Goldman Sachs. These types of outsourcing is usually on the low end of the payscale, unnaturally raising the average of the lower pool.

Similar pool problem are labor market disparities. A company whose employees are primarily in Bangladesh will be paying their lower pool significantly less than the upper pool. At the same time, the disclosure is actually made worse but hiding the disparity it is actually trying to reveal: American disparity. So, does one exclude foreign employees?

Still, the greatest benefit to my proposal is getting an understanding about how what the pay disparity is between those who are working to pump up the value of their stock and those who are trying to increase their cash compensation. This will also require the firm to put everyone in two buckets, forcing them to make a decision about what roles should be trying to pump up the stock and what roles are to be productive.

But these are implementation problems. Politicians and interested parties are still arguing over whether such information in important to shareholders. Republicans are saying that the purpose of the rule is to produce societal pressures on corporations, not actually add informational value to shareholders. I don’t have a problem with putting societal pressures on corporations, but I do wonder if this really should be the role of the SEC or if it should be the role of the DOL. Democrats and Labor are saying that the information is going to be important for shareholders because they will be given another key piece of information about how to pay their executives, which shareholders do in a vote each year.

Should corporations be required to disclose the pay ratio between its top executive and the average worker in the firm?

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.

You may or may not have heard about something called a Resolution Plan. A requirement from Title 1, Section 165(d) of the Dodd-Frank Act, any bank holding company with assets greater than $50 Billion is required to have one submitted to the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). The Plan is specifically fulfilling the requirement in subsection 1 of the section. It has three enumerated requirements and one catch all requirement. The enumerated requirements are: the extent to which the institution is adequately protected from nonbank subsidiary risks; descriptions of the org structure, assets, liabilities and other obligations; and enumerate collateral with which securities are guaranteed. The catch all requirement just states the institution must provide “any other information that the Board of Governors and the Corporation jointly require by rule or order.”

This is a yearly exercise banks must pass in order to keep their bank charters. The idea is that the two major insurers of these institutions receive enough information so that there is enough insurance to cover for any losses by depositors and debtees. Unlike regular insurance plans, the insurance premium won’t go up. That has been taken off of the table. Instead, the institution could be required to increase its ability to cover for the risks.

The risks are measured using Basel 3 standards. Metrics such as CCAR and CVar are used to determine a financial instrument’s ownership and level of risk. So, basically this is an exercise in accounting, primarily, and finance, secondarily.

Despite the title of the section, it is left up to the Fed and the FDIC to figure out if a resolution plan can be derived from the requirements. That is to say, the “Resolution Plan and Credit Exposure Report,” submitted by the institution does not actually contain a plan on how to resolve a dissolution of the institution. It provides information with which the Fed and FDIC can do so.

For banks that are smaller and simpler, FDIC is implementing a plan to perform the exercise itself, taking the burden of performance off of these other institutions that do not face direct risks from collateralized securities.

Credit Unions have their own equivalent to the FDIC called National Credit Union Administration (NCUA). There are some similar rules for credit unions but because of the limited offerings credit unions are allowed to provide, the risks are inherently lower, therefore, the standards are lower.

This short explanation is a good start to understanding the goals DFA Title 1 Section 165 (d)1.

Photoshopped image of Alan Greenspan, former Chairman of the Federal Reserve Board

Essentially, Tier 1 are what most people think of as shares of a corporation and what the bank has earned and retained over the years. Retaining the earnings rather than using it to provide dividends is a way to increase the assets of the organization, build a reserve to be deployed when needed. Tier 2 are preferred equity and long term debt the bank borrows, leverage.

The Capital is there to fund the business when business takes a sudden downturn. The 10% standard means that business can suddenly take a 10% dive and the bank will still be solvent. When CAR is 0%, the bank must start selling its assets to pay for its debts. One way to reduce the likelihood of avoiding this level is to be able to deploy borrowed funds that are due later to pay for the ones that are due currently. While this doesn’t mean the bank is healthy, but this gives the bank time to rebuild its reserves.

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.

Hybrid securities are securities that have features of both debt and equity.

Wall Street 1929

The classic example of a hybrid instrument is a convertible bond. This is, generally, a corporate bond with a condition attached to it. This condition states that if the equity shares of the corporation issuing the bond hits a certain valuation in the market, the bondholder will be allowed to exchange the bond for a certain number of shares. The number of shares is determined by the bond’s principal value, which is almost always $1000, and how many shares that principal could buy. For a buyer of bonds, this reduces the risk of losing out on exposure to equity if the issuing corporation does very well, without losing the status of a bond, which, as a debt, will be paid back before assets are distributed to non-debt liability holders. For the issuing corporation, usually the bonds hold a slightly lower interest rate than it would otherwise.

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.

Scenarios simulated are not arbitrary. There are 28 variables and they are based on historical economic crises. The variables are such things as rise in unemployment, rise in oil prices, rise in interest rates, fall of the GDP or a sudden equity market crash. National banks and federal savings associations are categorized into two for the simulation: those with more that $50 Billion in assets and those with less. Those with less than $10 Billion are exempt from participating in the Test.